Disappointing clothing sales in a tough U.K. market, where M&S generates almost 90% of its sales, have heaped pressure on Chief Executive Marc Bolland and his turnaround strategy.

The company's outlook seems to be brightening, however, as it slowly patches up clothing sales, which weren't exactly shredded in the economic downturn, although they have suffered a few holes.

Patience with management and the company's performance has been wearing thin, but definitive signs of improvement can drive the shares sharply higher. The stock (ticker: MKS.UK), which closed on Friday at 3.73 pounds ($4.40), can reach £4.45 in the next 12 months, according to analysts at Société Générale, suggesting upside of more than 20%. (M&S has American depositary receipts that trade in New York under the ticker
MAKSY.
maksy -0.5050505050505051%Marks & Spencer Group PLC ADSU.S.: OTCUSD15.76
-0.08-0.5050505050505051%
/Date(1427840401000-0500)/
Volume (Delayed 15m)
:
141652AFTER HOURSUSD15.76
%
Volume (Delayed 15m)
:
125310
P/E Ratio
15.429540299197617Market Cap
13117756503.5485
Dividend Yield
2.453045685279188% Rev. per Employee
199936More quote details and news »maksyinYour ValueYour ChangeShort position
They closed Friday at $11.99.)

But bulls on M&S, which has a market value of $9.4 billion, are a very small minority right now. Almost 3% of M&S' London-listed shares are loaned out, according to Markit, an indication that short sellers expect to cash in on a drop in price.

The stock has climbed about 13% in value in the past 12 months, lagging a gain of more than 14% in European stocks over the same period. It trades at about 11 times forecast 2013 earnings of 33 pence per share. That's a steep discount to U.K. rival
Nextnxt.ln -1.056338028169014%Next PLCU.K.: LondonGBP7025
-75-1.056338028169014%
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Volume (Delayed 15m)
:
662116
P/E Ratio
0.16838683537156932Market Cap
10854021828.125
Dividend Yield
2.8469750889679717% Rev. per Employee
76138.8More quote details and news »nxt.lninYour ValueYour ChangeShort position
(NXT.UK), which trades at a 12-month forward price/earnings ratio of almost 14 times. Historically, M&S has traded at a premium to Next.

IN A FIERCELY COMPETITIVE U.K. market, where consumers are watching every penny, Next and other clothing retailers have found it all too easy to steal market share from M&S. Customers struggled to navigate their way around M&S stores, and, when they did, they couldn't find the right stock or the correct sizes. That forced M&S into less profitable end-of-season discounting.

But M&S is fighting back. It already has a strong brand and attracts plenty of footfall. While continuing to open more outlets, it has invested heavily to improve the layout of its stores and to make its supply chain and information technology more efficient. Capital expenditure is estimated at £825 million in the current fiscal year, an increase of about 10% year-on-year. It offered fewer promotions over the important Christmas period.

There's plenty of scope for margin improvement. The profit-margin differential between M&S and Next is like comparing a small sweater with an extra-large: M&S' margin of earnings before interest and taxes in 2013 is estimated at 8%, versus Next's 18%.

SOME INVESTORS THINK it is only a matter of time before M&S' strategy starts to eat into that deficit. "All they have to do is get their loyal customers to spend a bit more," says Richard Colwell, a fund manager at Threadneedle Asset Management in London, who began buying M&S about 18 months ago.

Sales of general merchandise, which includes clothing, fell 0.9% in the year to March 31. Food sales, which account for more than half of M&S' total sales, were up 3.9%. Total sales in the last fiscal year grew 2%, to $16 billion. They are expected to edge up to $16.2 billion in the current fiscal year and to $16.8 billion through fiscal 2014.

Earnings are expected to climb to 35 pence per share through March 2014.

Capital expenditures should start to come down through that date, permitting M&S to generate excess cash of more than $323 million a year. That will allow it to pay down some of its debt—$3 billion at March 3—or to follow the examples of Next and
Debenhamsdeb.ln -2.775984506132989%Debenhams PLCU.K.: LondonGBP75.3
-2.15-2.775984506132989%
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Volume (Delayed 15m)
:
3409477
P/E Ratio
0.10624814100190902Market Cap
950032211.145088
Dividend Yield
6.374501992031872% Rev. per Employee
81914.8More quote details and news »deb.lninYour ValueYour ChangeShort position
(DEB.UK) with rolling share buybacks.

M&S already pays a generous dividend yield of almost 5%. Colwell says that means he can afford to be patient while he waits for M&S to deliver on its turnaround. "The prize is there. It's about execution," he says.

There's also a chance that any more signs of weakness at M&S could tempt a predator to make a bid. The company has been unable to shake off speculation that it is a prime candidate for a buyout since a failed bid by U.K. retail tycoon Philip Green in 2004. It wouldn't be a surprise to hear that potential buyers were running the rule over M&S, although financing in the current environment would be problematic.

A buyout would be a windfall for shareholders, but investors shouldn't count on that. Instead, they should rely on M&S to show improvements from its turnaround strategy. Next looks fully valued, so M&S can be the next best thing.

THE STOXX EUROPE 600 index closed on Friday at 287.08 points, down 0.03% on the week.